By Galit Altstein
Israel will have to sell a near-record amount of bonds this year to fund its war against Hamas, according to several finance ministry officials with knowledge of the matter.
The task got more complicated on Friday, when Israel’s credit rating was downgraded for the first time ever. Moody’s Investors Service cut the government one level to A2. While Israel’s still well within investment grade territory — and now on a par with the likes of Iceland and Poland — the move underscored the economic toll the conflict’s taking on the nation.
The government is likely to rely heavily on shekel debt markets as it increases its issuance, said the financial officials, who spoke on condition of anonymity so they could discuss sensitive matters. But it’s also set to sell more foreign-currency bonds, especially via privately negotiated deals.
Israel is under increasing pressure, including from the US, to wind down its operations on Gaza and ease the suffering of Palestinian civilians. Yet fighting continues to rage and the Israeli military says it may take until next year to achieve its goals.
The war will “materially raise political risk for Israel as well as weaken its executive and legislative institutions and its fiscal strength,” Moody’s said when it announced the downgrade after markets had closed for the week. “Israel’s debt burden will be materially higher than projected before the conflict.”
As the financial costs grow, Israel’s on track to run one of its widest budget deficits this century. The government envisions raising more debt in 2024 than in any other year bar 2020, when it had to spend and borrow heavily to contain the fallout from the coronavirus pandemic and lockdowns, according to the officials.
Analysts in the private sector agree. Total debt issuance will be around 210 billion shekels ($58 billion), an increase of nearly a third from last year, according to Alex Zabezhinsky, chief economist at Meitav DS Investments. In 2020, the figure was 265 billion shekels.
The burden will fall largely on a domestic market that authorities usually tap for about 80% of their financing needs, reducing their reliance on volatile foreign capital flows.
It’s a strategy that focuses on Israeli pension funds and other large institutional investors, which together manage almost 3 trillion shekels of savings. That should be enough to ensure Israel’s borrowing costs keep steady, at least for the next six months or so, according to Mozamil Afzal, London-based chief investment officer at EFG Asset Management.
Foreign Private Bonds
Government revenue has dropped sharply since the conflict erupted with Hamas’s attack on southern Israel from Gaza on Oct. 7. And spending will surge by the equivalent of $19 billion this year — no small sum for a $521 billion economy — to pay for more defense and programs such as reconstructing destroyed settlements.
Even so, officials at the accountant general’s office, who are in charge of managing Israel’s $300 billion debt stock, believe the economic strain will ease as the military scales back some operations and more reservists are allowed to return to their jobs.
They said investors are optimistic about the country’s financial outlook, based on recent meetings and conversations they had in the US and elsewhere.
Israel’s growing defense spending is a concern, the officials said, though the feedback was that recent measures, such as new taxes, should ensure a stable ratio of debt to gross domestic product in the years ahead.
Since the conflict began, Israel has not issued foreign-currency bonds in public markets. And it’s in no rush to do so, according to the officials.
The government’s instead sold debt in dollars, euros and yen through private placements, which are typically bought by a few investors at most. Those have been arranged by banks such as Goldman Sachs Group Inc. and Deutsche Bank AG.
Israel carried out at least four such deals in January, including three top-ups of existing euro-denominated securities and a rare bond in Brazilian real that will be repaid in US dollars. In total, they netted about $1.7 billion in proceeds, as part of foreign borrowing that could exceed $10 billion in 2024.
Domestic issuance in the first two months of this year is projected to total the equivalent of more than $9 billion, a 350% rise from the same period last year.
Zabezhinsky, the economist at Meitav in Tel Aviv, said Israel will need 125 billion shekels to finance the 2024 budget deficit and about 85 billion shekels to refinance maturing debt.
Israeli markets have stabilized after the turmoil unleashed in the first weeks of the conflict and the shekel’s now stronger than its level at the outbreak. Policymakers even cut interest rates last month.
Still, the government has a tall task ahead in paying for a war bill the central bank estimates will come to almost $70 billion — more than 10% of annual GDP — over 2023-2025.
Israel’s budget for 2024, which is pending final approval in parliament later this month, projects a fiscal deficit of 6.6% of gross domestic product, an increase of more than 2 percentage points from 2023.
The shortfall could be even higher if heavy fighting in Gaza is prolonged, or if Israel’s near-daily skirmishes with Hezbollah militants in Lebanon escalate. Both Hezbollah and Hamas are backed by Iran and considered terrorist organizations by the US.
Should the war in Gaza continue at its current intensity for many more months, Israel’s ability to source funding from institutional investors at home “can certainly come under pressure,” according to EFG’s Afzal. “Israel will then need to go to foreign funding sources, which means higher yields.”
Yields on the government’s 10-year shekel bonds have risen almost half a percentage point since late December, though they remain below their peak of close to 5% after the war broke out.
Israel’s public dollar bonds trade at an average yield of around 5.6%, according to Bloomberg indexes. Finance ministry officials told Bloomberg the sale in Brazil, which raised the equivalent of almost $500 million of debt due in 2027, will pay investors a dollar-equivalent yield of about 5.3%. They said that was cheaper than the cost of a pure dollar bond for the same maturity.
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Many bond traders already priced in a downgrade, meaning the Moody’s cut may have a muted impact when global markets reopen on Monday.
Still, the cost of insuring against an Israeli default — as measured by credit default swaps — is now higher than that for lower-rated sovereigns such as Mexico and Indonesia, indicating some investors are nervous.
Israeli Prime Minister Benjamin Netanyahu insists they shouldn’t be.
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